(Editor's Note: This article discusses some of the quantitative trends affecting Standard & Poor's Rating Services' analysis in 2007 for all 18 sovereigns rated in Latin America. A wider selection of economic indicators can be consulted in the recently published Sovereign Risk Indicators for 113 sovereigns rated by Standard & Poor's, which is published semiannually in January and July. In addition, a commentary comparing sovereign rankings globally titled "Sovereign Risk Indicators: 2007 Outliers" was published today.)
Only two Latin American sovereigns—Chile and Mexico—have investment-grade ratings. At year-end 2006, only eight Latin American sovereigns out of a total of 18 had foreign currency credit ratings that were higher than they were in 2000. Over this same time frame, the credit ratings on seven sovereigns deteriorated, and the ratings on three remained unchanged (see Table 10 for a list of all rated sovereigns in the region).
Latin America has gone through two very different economic periods so far this century. In the first couple of years of this century, many Latin sovereigns experienced significant political and economic crises that led to worse creditworthiness. (Examples include Argentina's default in 2001, Uruguay's default in 2002, Venezuela's political crisis and near default in 2003, Brazil's recession in 2001-2002, and Bolivia's ongoing political crisis since 2003.) The region's average creditworthiness has started climbing back to where it was at the end of the last century only since 2004, helped by sharp improvements in the terms of trade, more flexible exchange-rate regimes, debt reduction (including by defaulting in the cases of Argentina and Uruguay), and more prudent fiscal management in some countries.
In 2006, GDP growth for the region as a whole was about 5.5% (all data come from the Sovereign Risk Indicators tables). No rated Latin sovereign experienced negative growth in 2006 or in 2005. The Dominican Republic, Venezuela, and Argentina recorded the fastest growth rates, while Paraguay and Brazil had the lowest growth rates. With the exception of the Dominican Republic, South American countries grew faster than Central American countries.
GDP growth is likely to approach 4.6% in 2007, led by small countries like Panama and Dominican Republic as well as by Peru (see Tables 1, 2, and 3 for regional GDP and growth rates). Growth is likely to be modest for the two largest regional economies—Mexico and Brazil—at about 3.5% in each of them.
Falling External Debt
The Latin American region has benefited in recent years from good external conditions. High commodity prices and easy availability of external capital have bolstered economic growth and facilitated the implementation of improved debt-management practices throughout the region. The terms of trade for the region as a whole—a measure of the change in export prices compared with the change in import prices—are better than they were in the past decade, largely because of higher commodity prices. This external stimulus has helped boost economic growth, especially in South America.
The direct impact of higher commodity prices has been on the balance of trade, which has been in surplus in Latin America as a whole since 2002. Moreover, the regional trade surplus has been growing in recent years. The region's balance of services remains in deficit, but the deficit level has been stable in recent years. The net result is a current account surplus for the region since 2003, boosting foreign exchange reserves and reducing net external debt (see Chart 1).
Chart 2 shows the simple average of current account balances in the region, not the total absolute value of the balance. Much of the regional current account surplus arises in only a handful of sovereigns, such as Venezuela, Brazil, Argentina, and Chile. All regional data in this report are based on simple average calculations (see Table 6 for country data).
The sharpest improvement in the net external position has been in Venezuela, which was a net creditor by this measure in 2006 compared with a net debtor position only a few years before. Interestingly, all other sovereigns in the region are in a net debtor position, showing the region's traditional dependence on external capital. Narrow net external debt fell to 132% of current account receipts (CAR) in Argentina last year, but that country still has the second-highest burden for this measure in the region, exceeded only by that of Panama. Belize, which is now in selective default on its debt, has the next highest external debt burden, at about 124% of current account receipts (see Table 9 for individual country data).
Chart 1
The reduction in external vulnerability has boosted creditworthiness in several sovereigns. Overall, the region is better prepared now to absorb an external shock than it was in 2000. The (simple) average current account deficit in 2000 was of 3.3% of GDP. It fell in 2006 to 0.7% of GDP (see Chart 2) and is likely to expand toward a bigger deficit of 1% of GDP in 2007.
However, the biggest and third-biggest economies in the region (Brazil and Argentina, respectively) enjoyed current account surpluses in 2006, and Mexico, the second-biggest economy in the region, had a very small deficit. Venezuela is likely to again have the biggest current account surplus in 2007 because of oil exports, while Brazil is likely to run a surplus similar in size to its surplus of last year. Central American countries (which typically are net importers of commodities) are again likely to run the biggest current account deficits in 2007. Some of them, like Costa Rica, can largely fund the current account deficit with foreign direct investment inflows. Others—such as Panama, Guatemala, and El Salvador—will depend more on debt inflows.
Chart 2
The data for gross external financing show a similar pattern. Of the top nine countries with the largest external financing needs, all are from Central America (with the exception of Uruguay). Peru, Bolivia, and Venezuela have the lightest external financing needs in 2006 and 2007 because of healthy exports of natural resources (see Tables 7 and 8 for individual country data).
Gross external financing needs for the region as a whole in 2000 were at about 121% of CAR plus usable reserves, whereas in 2006, they were down to 100% of CAR (see Chart 3). External debt, net of liquid assets, in 2006 is expected at 54% of CAR, a significant improvement from the 110% of CAR recorded in 2000.
Chart 3
Better Fiscal Profile
This reduction in external vulnerabilities has also been accompanied by a significant improvement on the fiscal accounts (see Table 4 for individual country data). Fiscal balances have improved in most of the region The average general government fiscal deficit expected for 2006 is about 0.2% of GDP, which compares very well with a deficit of about 3.6% of GDP recorded in 2000 (see Chart 4).
The average figure includes massive fiscal surpluses in countries like Chile (estimated to be 7%-8% of GDP in 2006 because of high copper prices) and more modest surpluses in Argentina and Venezuela (both less than 1% of GDP). Nevertheless, Brazil continues to run a general government deficit of just under 4% of GDP, a modest improvement from previous years.
Chile is likely to again enjoy the largest fiscal surplus in 2007, even if copper prices continue to decline from their current high levels. However, most Latin American countries, including the bigger ones like Brazil and Mexico, will again be in deficit. Although its general government deficit is likely to decline modestly towards 3.4% of GDP in 2007, Brazil will again have the largest fiscal deficit in the region.
Chart 4
It is encouraging to note that government revenues have generally increased as a share of GDP in the region while spending has increased at a slower pace, allowing the primary budget surplus to increase. That, in turn, has given sovereigns the resources to either retire debt or reduce the pace of new borrowing.
Chart 5
The overall debt burden of Latin American sovereigns (measured as a share of GDP) has not improved as much as the external indicators of debt. General government debt (net of government liquid assets) is expected to have fallen below 35% of GDP in 2006 and is expected to reach 32% in 2007. However, the recent decline in the general government debt level is largely a recovery from higher debt levels in the recent past. For example, general government debt on average for the region was 36% of GDP in 2000 (see Table 5 for individual country data).
Belize has the highest debt burden in the region at more than 84% of GDP, followed by Argentina at about 61%. Based on current projections, both Chile and Venezuela could become net creditors in 2007 because of high commodity prices, which have allowed their governments to retire debt and to acquire assets.
Interestingly, all Latin American countries (other than Belize and Argentina) currently have debt levels of less than 60% of GDP, the threshold level set by the European Union (under the Maastricht Agreement) a few years ago for European countries that sought to join the union's common currency. Latin American countries have far weaker revenue bases and shallower domestic capital markets than developed countries in Europe do. As a result, they run a higher risk of debt default compared with developed European sovereigns at the same level of debt (as measured against GDP).
The improvement in external measures of debt in Latin America in recent years reflects many sovereigns having taken advantage of the favorable conditions in the external market to develop their domestic capital markets, thereby gaining more sources of funding. Governments throughout the region have sought to reduce their foreign currency debt by replacing it with local currency debt, reducing the exchange rate mismatch between their liabilities and their revenues.
The switch from foreign to local currency debt is favorable from a ratings perspective, as the new debt profile typically reduces the vulnerability of the government's finances to an exchange rate risk or to a negative external shock. However, the overall levels of general government debt remain high in Latin America, when viewed against the typically narrow tax base or the volatility of government revenues (especially for large commodity exporters).
The encouraging macroeconomic performance of recent years in most Latin American countries is expected to continue in 2007. Large countries—such as Brazil, Colombia, Chile, and Peru—now enjoy a positive outlook on their sovereign ratings, indicating the possibility of higher sovereign ratings in Latin America in 2007.
